Foreclosures and Short Sales: the Dangers of Buying Them

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Here’s a quiz. You should buy a foreclosure or short sale if:

a.) You have all the time in the world to buy, close and move in.
b.) You want to buy all new appliances, lighting fixtures, carpet, furnace, AC, cabinets and vanities anyway.
c.) You are extremely handy and/or have the ability to do trades for services, OR you have a lot of cash on hand for surprise issues. d.) All of the above!

You can probably guess what is the most likely scenario if you choose to purchase a foreclosed home or short sale. You must be prepared for all of the above (and more) if you enter into the purchase of a foreclosure… That is, IF you can close at all!

Fact: Less than 2% of buyers actually close on a foreclosure property.

You may be under the impression that people all over this country are scoring great deals on fabulous bank-owned properties (foreclosures are typically listed at about a 25% discount), but the realities are quite different. Going under contract and successfully closing on a foreclosure is extremely difficult, and not many average homebuyers are doing this! This process is time consuming, risky, and you must have a lot of cash!

Here are some major factors involved in buying foreclosures and short sales:

1.) The bank will almost NEVER negotiate on price. You have to enter into the bidding with your highest and best price and hope that you beat out the other buyers and investors that likely have put in better offers. You get one chance with the bank. The best deals on foreclosures have multiple offers in 24 hours and sell over asking price, so be prepared for that if you want the house.

2.) Homes are sold AS IS, which means absolutely NO negotiating at all for roof repairs, termite treatments or anything. Any repairs that need to be done (and they are usually numerous) are already going to be factored into the price of the home. This is why these prices always look so low. This means you’ll need to have the cash or credit to make the fixes after you buy the house because you can’t get that worked into your mortgage.

For example, if FHA requires a termite treatment because of evidence of past damage before they will give you a loan, you will need to pay for this BEFORE you can close. This can cost anywhere from $500 to $1000.

Typical repairs during a sale on a well-maintained home usually cost about $500 to $1500. Foreclosures are usually poorly maintained, and are frequently even trashed or gutted — repairs on these properties can run from $5,000 to $20,000.

3.) The bank owning this property will NOT pay any of your closing costs. Again, they’re selling this to you at a discount, so that’s the only benefit you are getting. In contrast, my clients purchasing homes from traditional sellers are getting between $3,000 to $6,000 of seller paid closing costs!)

4.) Think of the steps involved in any purchase, and imagine those steps complicated by bank ownership and lengthy home vacancy. You’ll have to do an inspection after your offer is accepted and before you move into the house. (You’ll definitely have to pay for this inspection yourself, usually around $400.) If the foreclosure is vacant — and they usually are — the utilities will be off. In order for the inspection to be done, you’ll have to pay the typical $60 fee to have the utilities turned back on (so the inspector can test them). If the previous owner was in debt on their utilities, you will have to pay the debt in order for the utilities to be turned back on for this address. This could be between $300 – $1500, depending on the situation.

Also, with your home purchase you most likely have a lender and a Realtor. By attempting to purchase a foreclosure or short sale, you are completely eliminating any work this team can do on your behalf. Because there is no negotiating with the bank, and no real communication is possible. For instance, my lender Sharon Natarus (Wells Fargo) says, “A traditional closing would take 30-45 days. I would not even guarantee nor estimate a time line for a foreclosure. You are at the mercy of the bank.” Your lender or Realtor can’t do anything to expedite or smooth out the details of the sale. You are, as Sharon says, at the mercy of the bank who owns the property. In a traditional sale, this is not the case.

5.) If you are trying to purchase a foreclosure or short sale with a loan, the bank will likely put your offer at the bottom of the stack. Even if offers are $20,000 less than yours. The bank owning the property wants cash offers. They do not want to deal with conventional, FHA or VA loans. These loans take too much time, usually require seller-side requirements that the banks can’t deal with meeting.

For instance, if you are getting an FHA loan to buy this property, the bank knows that the FHA is not going to appraise the house as high as you are offering, and that FHA will require repairs that the bank isn’t going to make.

Your lender may also not be keen on your loan anyway — this makes you an unattractive candidate to all parties. The bank owning this property is going to hold out for cash. Lender Sharon Natarus says, “There are some great deals for investors that have the ability to pay cash for the properties. It is very challenging for a borrower. If we are going to finance a property, we want the house to be livable and safe for the borrower.”

The bank who owns the property is also going to prefer the kind of offer that requires no inspection and can close in two weeks. These offers do exist! There are investors, flippers — people who have cash — buying these types of properties to make money. And these are the people who are typically closing on these foreclosure properties.

6.) Banks who own these foreclosures are notoriously unresponsive. For example – you may put in an offer on this property on day one. Then the bank may wait until day 45 to review all offers, and respond to one of them. The bank then works with the one offer and MAY inform you on day 50 that your offer was not accepted. During this time, you cannot put an offer in on another property — you may even have to wait for response lag time to pull your offer if you want to make an offer on another home. Otherwise you could end up under contract for two houses.

Meanwhile, you’ve lost your invaluable time. You may have missed out on other properties you would have liked to buy, other opportunities (like the $8,000 tax credit), the start of a school year, job relocation, lease ending, sale of another home, etc. Time can be priceless in a real estate transaction.

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Managing Expectations
Let’s take a moment to manage expectations. First of all, you wonder why this home could be so bad or so expensive?

Imagine that you owned a home, paid money into it for years, and maintained and upgraded it, perhaps. Then for whatever reason you can’t pay the bills anymore. (This is happening to all types of homeowners, not necessarily people who are just “delinquent.”) Suddenly, the bank kicks you out, leaving you homeless with a terrible credit record.

These homeowners become angry and feel victimized. They retaliate by selling or destroying anything worth value, which you will have to replace with new — refrigerator: $800-1000, oven/stove: $400-$1000, dishwasher: $200-800, cabinets: $1500-8000, carpeting: $700-2000, furnace and AC units: $4000-9000. Anything that can be removed will probably be removed. I have seen them take out closet racks, toilet paper holders, light switches and plates — anything you can imagine. Think about the cost of replacing all of these things.

Then there are the things you can’t see: often, objects are flushed down toilets to break down waste lines and destroy the plumbing. Water can leak out into this house without any heating or cooling, causing a breeding ground for growth of biohazards and mold. Plus, these houses can sit empty for a long time! This can invite in a host of problems. Note: Many lenders require a working kitchen and bathroom in the home for a loan to be approved! No plumbing, appliances or fixtures do not make operable kitchens and bathrooms. Sharon Natarus confirmed this fact for us.

Plus the things we already mentioned: back payments owned on utilities, and also taxes and even medical payments — these missed payments can put liens on the home. Imagine a homeowner no longer able to afford house payments. There are likely other payments owed on the house as well. Frustrated buyers trying to close on a foreclosure or short sale often end up just paying some of these things instead of waiting the very long time it can take to get resolved.

This foreclosed homeowner is not thinking about future owners — they are trying to lower the amount the bank will get from their home or inhibit the bank’s ability to sell it. What would you do if it happened to you?

Secondly: consider the bank. Don’t expect the bank to be benevolent or accommodating. All they want to do is deal with the home as little as possible and get as much money from it as possible (which probably isn’t much compared to what they’ve lost on the mortgage). The bank is left without payment for this home, and the bank is a business. This is a business transaction for them and nothing more, and surprisingly enough, banks will take a very long time to deal with offers and other matters on foreclosed properties.

The bank probably owns many foreclosed properties they have to deal with. Do you really expect your traditional offer, paid for by a loan, with potential negotiations on cost or repairs to be a priority for this bank? You are probably not the buyer they are looking for.

Bottom Line: Yes, these homes might come with a 25% discount. Then factor in the following items we have discussed:

Zero negotiating

No payment for extensive repairs

Extremely slow response time from bank

Difficulty receiving a loan

No estimable closing date

Paying off bills of previous owner

A home that is likely gutted or trashed

Invisible problems that may be revealed after inspection

Time and potential opportunities lost while you wait for your foreclosure purchase to become final

I think we know where your 25% savings is going to go. This is not like purchasing furniture at a scratch-and-dent store, or clothing at an outlet. These things might be worth buying at a low cost even though they’re a little bit shoddy. But this is your home, your most major investment, the place where you will be living your life every day and perhaps raising a family. Do you really want to take these chances? And do you have the kind of money it will take to walk away with this “bargain?” If you’re answer is not a very firm yes, you will seriously want to reconsider entering into the purchase of a foreclosure property.

“That the 25 percent you just saved on the purchase price can easily be eaten up by unforeseen expenses such as repairs not immediately apparent in an exterior inspection. That’s because when you buy a home in foreclosure, you may not be able to look inside let alone have an inspector detect structural problems that you’ll need to fix before moving in. “

“Most of the time it’s investors, not individual home buyers, who make the riskier deals for foreclosures like buying them as-is in cash… as more home buyers become interested in purchasing a foreclosure, they need to be more mindful of the potential hazards. … All of our experts said that foregoing an inspection would be a bad move anytime, and would be especially risky when dealing with foreclosures.”

“I have seen picture of vacant foreclosures that are completely wrecked. Mold on the walls up 3-4 feet, dog [waste] all over. Broken walls and cabinets, missing fixtures, and the like. Still want to buy a foreclosure?? It gets worse! By law, they cannot even give a home warranty on the home, there is no termite inspection and the transaction is minimally monitored except the auction it off at the county courthouse. Nice looking little foreclosure might look nice on the outside, but inside is a whole other matter.”

“Depending on when the Notice of Default was filed, the lender’s back-log of foreclosures and how much paperwork the seller has already submitted, it could take anywhere from two weeks to two months to get a response on a purchase offer from a lender. In addition, if two lenders are involved because there are two loans secured to the property, it could take longer to satisfy the demands of the second lender.”

“A foreclosure deal may be loaded with surprise expenses because foreclosed properties are often in disrepair. Such properties also can come with titles encumbered by judgments, liens, and other attachments you may have to pay off to seal the deal. And even before you begin to negotiate, the homework necessary to research the market and property can cost you. Finally, a surfeit of foreclosures typically signals a declining market with the inherent risk of property value declines yet to come. You should have the financial wherewithal to see you through to the next upturn.”

“Hidden liens can be a big problem. If a homeowner had two mortgages and defaulted only on the second, the first is still binding. Auction officials aren’t obligated to tell you about debts outstanding, so unwary investors could be saddled with having to pay off that first mortgage, generally immediately. A full-blown title search on a house can cost $400 or more. … In many cases, it is the property’s first mortgage in default, in which case subordinate liens are eliminated in foreclosure. But watch out for exceptions: Internal Revenue Service liens and some utility bills will need to be paid off.”

“You will almost always be beat out by a cash offer. Financing will take some time and banks want these houses gone quick to a “ready, willing and able” buyer. I’m also noticing that the investors are back – making offers on these bank-owned properties without even seeing them in person”

“One of the most crucial things buyers need to know about buying a foreclosure is that it’s probably going to need at least some work before it’s livable. “It seems to me that a lot of people think that they can get a house that might not need any work other than cosmetic changes, but the truth is a lot of foreclosures need a lot of work. It could be missing the furnace or even the kitchen, or it could need a new roof,” said [Eric] Goosen, noting that if a home needs too much work, it may be impossible to get financing for the purchase.”